Market Corrections Are Expected

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I started my career in serving individuals and entities and their investment needs in November 1982, so 36 years in, I can reflect on this October’s volatility as just another one of these kind of crazy, yet to-be-expected episodes where the equity markets, or some other market(s), create considerable stress for many investors. While US and International equity returns are very attractive over the long term, we often forget that there will be periods of rather extreme volatility. Just as we get lulled into a sense of complacency, the markets tend to remind us that it isn’t always smooth sailing.

While sometimes these reminders are warnings of serious economic or geopolitical problems, often the volatility is just a healthy correction and is the market’s way of clearing away the excess froth in prices, even if the decline is rapid and jarring.

The recent sharp sell-off in the S&P 500 Index at the time of this writing retraced 9.37% from its recent all-time closing high on September 20th. This size of this decline is not out of line with other “normal” market corrections since the start of the current bull market in March 2009. While the current sell-off has happened over a short time span, it has not yet reached the definition of a correction (10% down), as we can see from the following chart.

SP 500 Corrections

S&P 500 Corrections Are Quite Normal

From the following chart we can see that deeper market declines are usually associated with economic recessions (shaded areas), which none of the current economic indicators are pointing towards at this time.

SP 500 Drawdowns

S&P 500 Drawdowns From high Since Start of Bull Market

The US remains on sound economic footing. Second quarter GDP was 4.2%, the Atlanta Fed model is forecasting a 3.6% GDP growth figure for the third quarter, which will be announced Friday, October 26. Unemployment is only 3.7%, the lowest level since December of 1969. Non-Farm Payrolls have been growing at a pace that will create more than 2 million US jobs in 2018. Yes, housing has been soft recently, but with the bad comes the good and the two recent hurricanes have a silver lining in that they damaged a lot of housing stock and which help to bolster building and construction. This new building activity is quoted as possibly adding as much of 0.2% to GDP in the coming quarter. Auto sales too have been weak, but the average age of a car in the US is now greater than 11 years and the replacement cycle looks good in the coming year.

We see this as a normal and healthy correction. Based on our assessment we plan on staying the course in our long-term asset allocation portfolios. Our tactical fixed income models had raised some cash about one month ago, and we are selectively deploying some of that right now. But as always, we continue to watch for any meaningful changes that would cause us to adjust our stance.

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